Massachusetts Legislature Passes Noncompete Reform Legislation

Summary

The Massachusetts Legislature recently passed legislation that, if signed by Governor Baker, will make substantial changes in the law governing future noncompetition agreements with Massachusetts workers and residents. This client alert describes the extensive changes that will apply to the terms of and steps for entering into noncompetition agreements, if the legislation becomes law.

The Massachusetts Legislature recently passed legislation to reform the law governing noncompetition agreements in Massachusetts, entitled the Massachusetts Noncompetition Agreement Act (the Act). The Act is part of a comprehensive economic development bill. To become law, Governor Baker must sign the bill by August 10, 2018. Although Governor Baker has not taken a public position on the bill, he supported similar proposed noncompetition legislation in 2016.

If the Act becomes law, new noncompetition agreements will be subject to significant limitations. Key changes if the Act takes effect include the following:

Noncompetition restrictions will be limited in most cases to one year after employment ends;

Noncompetition obligations will not apply to those who are terminated without cause or laid off;

Employers will need to provide garden leave payments or “other mutually-agreed upon consideration” to have an enforceable obligation;

Noncompetition obligations will only be able to be applied to employees who are exempt from overtime eligibility under the Fair Labor Standards Act.

These and the other changes that result from the Act if it takes effect are limited to noncompetition agreements. Agreements prohibiting solicitation of customers and employees will not be subject to these restrictions, although such agreements will remain subject to common law limitations.

To prepare for the Act’s effectiveness, Massachusetts employers will be required to review and, in many cases, substantially revise, their current forms of noncompetition agreements and to develop new processes regarding presenting noncompetition agreements to job candidates, employees and independent contractors.

This client alert answers questions concerning key aspects of the Act. The alert discusses key provisions of the Act based on the assumption that the economic development bill will be signed by Governor Baker.

Effective Date and Current Agreements

Q: When will the Act take effect?

A: The effective date of the Act is October 1, 2018.

Q: Will the Act affect agreements entered into before October 1, 2018?

A: No. Noncompetition agreements entered into on or before September 30, 2018, remain enforceable to the extent permitted by existing case law.

Covered Noncompetition Agreements

Q: What agreements are covered by the Act?

A: The Act regulates “noncompetition agreements,” which are defined as agreements between an employer and an employee or independent contractor under which the individual agrees that he or she will not engage in certain competitive activities after the relationship has ended. The Act treats independent contractors as employees, and therefore all provisions applicable to employees apply equally to independent contractors. The Act applies to agreements prohibiting competition regardless of whether the remedies for a breach consist of injunctive relief, damages and/or forfeiture of amounts otherwise due.

There are several exclusions in the Act. Among other exclusions, it does not apply to:

Agreements not to solicit or hire employees of the employer;

Agreements not to solicit or transact business with employer’s customers, clients or vendors;

Nondisclosure agreements;

Invention assignment agreements;

Garden leave clauses, subject to qualifications below;

Noncompetition agreements in connection with the sale of a business, subject to qualifications below; or

Noncompetition agreements made in connection with the termination of employment, subject to qualifications below.

Q: How does the exclusion for noncompetition agreements in connection with a sale of a business work?

A: Noncompetition agreements entered into in connection with the sale of a business are not covered if the party restricted is a significant owner, member or partner of the business entity and will receive “significant consideration” in connection with the sale.

Q: How does the exclusion for noncompetition agreements made in connection with the termination of employment work?

A: Employers and employees may agree to noncompetition obligations that are outside the Act in connection with an employee’s termination of employment for any reason, whether with or without cause, if the employee is given seven business (not calendar) days to revoke the agreement after signing it. Note that this seven business day revocation right is longer than the seven calendar day revocation right required to release claims under the Age Discrimination in Employment Act.

Required Components of Noncompetition Agreements

Q: What features need to be included in a noncompetition agreement for it to be enforceable under the Act?

A: A Massachusetts noncompetition agreement entered into from and after October 1, 2018, needs to include the following components:

It must be in writing and signed by both the employer and the employee.

It must include a statement that the employee has the right to consult with counsel prior to signing.

The restricted period may be no longer than 12 months from termination of employment, except that if the employee has breached his or her fiduciary duty or unlawfully taken property of the employer, the restricted period may be up to two years from termination.

The agreement needs to include a garden leave clause “or other mutually agreed upon consideration [that is] specified in the noncompetition agreement.”

The agreement must be “reasonable in geographic reach.”

The agreement must be “reasonable in the scope of proscribed activities in relation to the interests protected.”

In addition to these requirements, such agreements should not purport to apply regardless of the circumstances of termination, as the Act provides that a noncompetition agreement may not be enforced against an employee who is terminated from employment without cause or is laid off. “Cause” is not defined in the Act. If the noncompetition agreement includes a definition of “cause,” the employer should have a good argument that the court should apply the agreed definition.

Q: What are the required components of a garden leave clause?

A: A garden leave clause must provide for paying the employee at the rate of at least 50% of his or her highest annual base salary rate in the last two years of employment. That payment provision does not apply, of course, if the employee is terminated without cause or laid off, since the noncompetition provision may not be enforced in that case.

The employer may avoid paying the garden leave payments by waiving the post-employment restrictions of the noncompetition agreement before employment terminates. Once employment terminates and the post-termination noncompetition obligation is in effect, the employer may not cease payment in the absence of a breach. (However, if the noncompetition restriction continues for a second year due to the employee’s breach of fiduciary duty or unlawful taking of property, the payments need not continue for the second year.)

Q: What “other mutually-agreed upon consideration” is sufficient to serve as an alternative to a garden leave clause?

A: The Act does not define “other mutually-agreed upon consideration.” It is not clear whether there is any minimum threshold of value that is necessary for consideration to qualify as “mutually-agreed upon consideration” as an alternative to garden leave. What is clear from the Act is that whatever consideration is provided in place of garden leave needs to be set forth in the noncompetition agreement itself. There will no doubt be litigation over whether amounts that are far less than the value of garden leave constitute “other mutually-agreed upon consideration.”

Q: What makes a geographic reach “reasonable”?

A: Reasonableness needs to be determined based on “interests protected.” The only further guidance in the Act on this point is that a geographic restriction will be presumptively reasonable if it is limited to those geographic areas in which the employee “provided services or had a material presence or influence within the last 2 years of employment.” To satisfy the geographic reasonableness requirement, an employer should consider including this standard for presumptive reasonableness in its noncompetition agreements.

Q: What makes an agreement “reasonable in the scope of proscribed activities in relation to the interests protected”?

A: The Act’s guidance on this point is limited to stating that a restriction will be “presumptively reasonable” if it is limited “to only the specific types of services provided by the employee at any time during the last 2 years of employment.” As with the geographic area standard, to satisfy this standard, an employer should consider specifying this limitation in the agreement.

Q: Are there other standards that need to be satisfied for a noncompetition agreement to be enforceable?

A: Yes. Consistent with the current common law standard, the agreement must support the employer’s interests in protecting its trade secrets, its other confidential information and/or its goodwill. The Act specifies that the agreement must be “no broader than necessary” to support one or more of those interests.

Q: Are there different required components for agreements entered into after employment begins?

A: Yes. In addition to the standards above, an agreement entered into during employment (and not in connection with a termination of employment) “must be supported by fair and reasonable consideration independent from continuation of employment.” The Act does not specify what makes additional consideration “fair and reasonable.”

Required Procedures for Entering Into a Noncompetition Agreement

Q: Aside from modifying the text of noncompetition agreements, are there any steps that an employer must take to ensure that noncompetition agreements are enforceable?

A: Yes. For a noncompetition agreement proposed in connection with the commencement of employment, the agreement must be provided to the employee by the earlier of:

The formal offer of employment; or

Ten (10) business days before the commencement of employment.

For a noncompetition agreement proposed to an employee during employment but not in connection with the termination of employment, the employer, in addition to providing “fair and reasonable consideration” as described above, must provide notice of the agreement at least 10 days before it will be effective.

As described above, the Act does not apply to noncompetition agreements that are entered into in connection with a termination of employment as long as the employee is given seven business days to revoke acceptance.

Employees Excluded From Noncompetition Agreements

Q: Are there any categories of employees who cannot be subject to noncompetition agreements?

Undergraduate or graduate students who are in an internship or other “short-term employment relationship” during the period of their full-time or part-time studies; or

Employees who are 18 years old or younger.

Judicial Rewriting of Noncompetition Agreements

Q: If a noncompetition agreement does not satisfy the Act’s requirements, can it be modified by a court to make it valid?

A: Yes. A court has the discretion but not the obligation to revise a noncompetition agreement to render it enforceable.

Choice of Forum

Q: May an employer choose a location for a lawsuit convenient for it?

A: Not necessarily. A noncompetition agreement could provide that any lawsuit about the agreement will be brought in Suffolk County. If not so agreed, the location will be the county where the employee resides.

Choice of Law

Q: May an employer avoid these restrictions by selecting a different state’s law?

A: No, not to avoid application to Massachusetts workers or residents. Specifically, if an individual has worked in Massachusetts or been a resident of Massachusetts for at least the 30-day period immediately preceding the termination of employment, the Act will apply, regardless of a choice of law provision to the contrary.

Conclusion

If the economic development bill becomes law, the Act will take effect and will require profound changes in practices for noncompetition agreements for Massachusetts employers that rely on noncompetition agreements to protect their businesses. Among other things, employers will need to carefully review and revise their existing noncompetition agreements, use them only with a subset of employees and ensure that they provide statutory notice when asking job candidates, current employees and independent contractors to sign new noncompetition agreements.